Bendigo & Adelaide Requires A Leap Of Faith

This story features BENDIGO & ADELAIDE BANK LIMITED. For more info SHARE ANALYSIS: BEN

Bendigo and Adelaide Bank has embarked on the three-year strategic plan in order to improve returns in a slower growth environment. However, brokers warn this requires a leap of faith by the market.

-Increased investment expenditure likely to drag on earnings in the near term
-Will the dividend be cut further?
-Mortgage growth the main positive aspect
 

By Eva Brocklehurst

Bendigo and Adelaide Bank ((BEN)) has cautiously outlined its decision to restructure, by raising capital, cutting the dividend and embarking on a three-year strategic plan. This is expected to be a catalyst for improving returns in a slower growth environment although, as Citi notes, there was limited disclosure on the details.

The bank has indicated net investment expenditure will continue to increase, to around $80m in FY22. While Macquarie believes the increased expenditure is justified, it will provide a material drag on earnings in the near term.

Bendigo and Adelaide is looking to partially offset these headwinds with an uplift in revenue but this is expected to be difficult to achieve in a low interest-rate environment.

Citi, too, points out management appears reluctant to unveil a detailed transformation plan, or fully commit, with only medium-term goals outlined. Moreover, a weak revenue outlook for the whole sector is likely to put pressure on the level of transformation the bank may be able to undertake. Hence, the dividend may be cut further.

The broker assesses the challenges for management largely involve the revenue environment, as financial indicators suggest cost growth on average of around 4% per annum over the next three years. In contrast, Citi expects revenue to average only 1% growth per annum over this period.

Macquarie suspects that the pay-out ratio is unsustainable, even with the dividend reduction, given the forecast return on equity is set to decline because of higher costs and narrowing margins.

An element of faith is involved in the outlook, Ord Minnett asserts, both in the bank's execution and in the ability to drive above-system loan growth. The broker struggles to understand how FY22 guidance for a cost-to-income ratio of 59.3% can be met. The broker now forecasts a sub-7% return on equity over the next three years. Hence the valuation is considered unattractive.

Credit Suisse assesses regional banks have a problem in that they do not have enough scale to spread the cost burden. The broker agrees the bank's aspirations require significant faith from the market, which is unlikely.

Capital

A $300m equity issue was announced which should increase the CET1 ratio to 9.8% from 9.0%. This comprises a fully underwritten $250m institutional share placement and a non-underwritten share purchase plan of around $50m.

The capital is expected to support residential lending growth and enable further investment in IT and regulatory-related changes. Macquarie suspects the raising is opportunistic, as first half revenue trends benefited from re-pricing, improved funding costs and hedging benefits.

Into the second half, the broker expects margin pressures will emerge and, given the investment plans, underlying earnings are likely to decline by around -15% over the next couple of years or so. The improved capital position and investment profile may be fundamentally positive for a longer-term outlook but the broker envisages the ultimate earnings recovery could be delayed to FY23.

Shaw and Partners expects the higher level of capital will probably be used to support higher capitalised software balances and whatever changes APRA announces. Shaw and Partners, not one of the seven stockbrokers monitored daily on the FNArena database, downgrades estimates and retains a Hold rating and $10.00 target.

Goldman Sachs is more positive and assesses the capital settings are now on a more sustainable footing, while there is evidence the business can grow loans in excess of system. The broker, also not one of the seven, upgrades to Neutral from Sell, noting the improving growth outlook and capital position and incorporating the dividend reduction.

Bell Potter, not one of the seven, believes the interim dividend would have been maintained if not for the capital raising and retains a Hold rating and $10.80 target.

Mortgages

The main aspect of the result that impressed brokers was the growth in mortgages, with residential lending growth of 7.7%, well above system. Net interest margins also beat expectations, increasing by two basis points in the first half

Growth was driven by broker origination of owner-occupied mortgages and Macquarie suspects the growing broker share of net business is likely to negatively affect margins over time.

Yet Shaw and Partners notes the bank has a gap of around 40 basis points between old and new mortgages which costs the net interest margin around -6 basis points every six months. Hence, the cost-to-income ratio is forecast to increase. Morgan Stanley also notes the lower "exit margin" of -6 basis points and highlights the risk to consensus earnings estimates in the second half.

There are six Sell ratings for Bendigo and Adelaide Bank on the database. The consensus target is $9.38, suggesting -6.4% downside to the last share price. The dividend yield on FY20 and FY21 forecasts is 6.2% and 6.0% respectively.

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